Natural gas losing decades old link to oil in landmark contract

Natural gas losing decades old link to oil in landmark contract

TARA PATEL

PARIS (Bloomberg) -- A contract for GDF Suez to buy the commodity from Azerbaijan shows the decades-old structure of Europe’s energy market is starting to crumble.

For the first time, GDF Suez signed a 25-year contract to buy gas from BP and partners in the former Soviet republic at prices tied to those in Western Europe’s domestic gas markets, a person with knowledge of the matter said, asking not to be named because the terms are confidential. The change matters because purchases previously were made at prices tied to crude oil, which costs about three times more, an expense then passed on to consumers.

Europe’s gas contracts have been tied to oil since the 1960s as a way of providing certainty to suppliers who would then invest billions to build fields and pipelines. More recently, as gas prices fell and oil rose, utilities including GDF and Electricite de France as well as Germany’s EON and RWE pressed Russian gas-export monopoly Gazprom and Norway’s Statoil to revise long-term agreements.

As the crisis in Ukraine pushes relations between Russia and the European Union to their lowest ebb since the end of the Cold War, regulators want more flexibility in gas prices as Europe looks to diversify supply, said Thierry Bros, a gas-market analyst at Societe Generale. Gazprom supplied about 30% of EU gas last year, but will likely be competing with exports from the U.S. as well as Azerbaijan in coming years.

“Producers want to stick with oil-indexed prices under a system that dates to 1962, while European regulators are saying consumers should pay gas prices,” Bros said.

BP, which is leading Azerbaijan’s Shah Deniz gas project and the Trans Anatolian gas pipeline that will bring the gas to Europe, said terms of gas contracts were confidential and declined to comment further.

The Shah Deniz partners have agreements to sell more than 10 Bcm of gas year starting in 2019 to nine different buyers, including Italy’s Enel and EON.The deals are equivalent to more than 2% of European demand.

GDF Suez’s contract for 2.6 Bcm a year will help to diversify European supply routes and sources, the company said in September when the deal was stated. Details of how much the gas would cost weren’t disclosed at the time.

State-controlled EDF has gone to arbitration in the past to win lower prices on natural gas supplies from Algeria, Libya, Qatar and Russia, Pierre Vergerio, COO at its gas arm Edison, said in November.

EDF and GDF Suez face pressure from the French government to win spot-market rates from suppliers as the country seeks to cut energy bills.

Gazprom will probably reduce the price it charges European buyers in a bid to defer competitors such as Azerbaijan, Societe Generale said in a March 19 report.

Gazprom’s market share in Europe is expected to plateau at about 29% in 2016 to 2018 after dropping to as low as 22% in 2010, according to the report.

Shah Deniz’s second development phase, estimated to cost $28 bn together with the associated pipelines, will start producing in 2018.

BP holds 28.8% of the Shah Deniz project, while Norway’s Statoil has a 15.5% stake. Azerbaijan’s state oil company, Socar, has 16.7% and Total holds a 10% stake. The other shareholders are Lukoil and the state oil companies of Turkey and Iran.